Fixed Annuities & Interest Rates – It’s All about The Spread

Denton: The US Treasury reaffirmed in its October 2014 statement its view that the current zero to ¼ percent target range for federal funds rate remains appropriate, which has resulted in the usual round of forecasting efforts by financial media outlets. Steve and I have had requests to jump into the fray, but we won’t. Predicting an increase or decrease in rates is not a retirement strategy, and it misses the point.

Gates: You got that right, Michael, and it’s not as though this is really new news. It’s common knowledge that low interest rates have been the bane of retirees for the past several years. That’s why we applaud insurers for keeping the yield as high as possible by creating new fixed index products and reducing commissions to keep annuity yields competitive.

Denton: I don’t want any financial advisors to misinterpret the gist of this discussion. I want an increase in rates as much as anyone. I know Steve does too, but it’s important to stay focused on the bigger picture. Despite low interest rates and declining commissions, fixed annuity sales keep going up and up. They reached $59.9 billion in the second quarter of 2014, a 6.8% increase from the previous quarter and a 9.9% increase from $54.5 billion in the year-ago quarter. So, if I’m going to predict anything, it will be that the fixed annuity market will grow.

Gates: Exactly. The reason for continued fixed annuity growth has to do with comparable alternatives. There aren’t any. When retirees go to the bank and discover that they’ve earned almost nothing on their savings accounts and CDs, they are shocked. Right now, the average CD rate is earning 40 basis points, while 5-year fixed annuity guarantees are up to five times that performance. The preferable option should be obvious. That’s why the question isn’t, “what’s the interest rate?” It should always be “what’s the spread?” I encourage producers to show the compounding effect of the spread between CD rates and fixed annuities in real dollars and cents.

D&G: So, here’s our recommendation for a fixed annuity game plan…

Older consumers look to annuities in this low-rate environment, precisely because CDs are not providing the returns they once did, and they can’t afford the downside risk of securities. Help clients lower their stress and financial risk by recommending appropriate fixed annuities.

Some clients are interested in fixed annuities, because they own existing annuities approaching the guarantee period. There are also seniors seeking tax-deferred growth who have maxed out their existing retirement accounts. Fixed annuities are an appropriate option.

Bond prices move in the opposite direction of interest rates, which has been good news for bond investors in recent years. There is real risk in the bond market though. At some point, rates will go in the opposite direction. Fixed annuities are an opportunity to diversify and balance your investors’ portfolio.

Be prepared for fence sitters who park money in 1-year CDs. While they wait for the interest rates to climb or for spikes in the market, they are missing out on guaranteed performance. Illustrate that loss over five years in real dollars and cents.
We cannot stress how important it is to focus on the spread. None of us are clairvoyant. Rates will go up or down, and in the interim money can be made. Investing in a fixed annuity is an excellent retirement strategy that provides guaranteed lifetime income, protection from market downturns, and the potential to earn tax deferred interest. They also offer different riders to cater to client’s personal financial needs.